UKRAINE: GAS SUPPLIES RESUME, BUT QUESTIONS ON GAS

UNCLAS SECTION 01 OF 03 KYIV 000107 SENSITIVE SIPDIS DEPT FOR EUR/UMB, NSC FOR STERLING AND KVIEN, EEB/ESC/IEC FOR SGALLOGLY AND LWRIGHT DOE FOR LEKIMOFF, CCALIENDO, RBOUDREAU USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK E.O. 12958: N/A TAGS: EFIN ENRG EPET PGOV PINR PREL UP SUBJECT: UKRAINE: GAS SUPPLIES RESUME, BUT QUESTIONS ON GAS DEAL REMAIN REF: KYIV 90 Sensitive But Unclassified. Not for Internet Distribution. Summary and Comment -------------- 1.(U)This is a request for guidance. See para. 3. ¶2. (SBU) The gas deal struck by Prime Ministers Tymoshenko and Putin on January 19 in Moscow foresees a swift move towards market pricing for both gas and transit and an elimination of intermediaries, two key elements of what is universally seen as a badly needed long-term gas strategy for Ukraine. Many questions remain, however. The two sides did not disclose how they intend to set market prices, and Tymoshenko has not yet explained why Ukraine compromised on the gas price without getting an immediate transit fee hike in return. Tymoshenko subsequently announced a deal on technical gas that at first glance looks beneficial to Ukraine, but goes far beyond what Ukraine needs for transit and may be part of a compromise to keep transit fees optically low and to settle outstanding debts of the erstwhile intermediary RosUkrEnergo. Gas began flowing on January 20, with Ukraine drawing gas out of storage to service other European countries while Russia opened the valves to numerous pipelines entering Ukraine. It does appear that RUE will be removed, but the fate of Gazpromsbyt, an intermediary servicing the Ukrainian domestic market, was not immediately clear. President Viktor Yushchenko has been silent since Tymoshenko's return from Moscow, but his Chief of Staff Baloha openly criticized the deal, saying that the lack of clarity on the price formula could hint at corruption, and that the 2009 prices cited by Tymoshenko and others -- on average about $230 per thousand cubic meters (tcm) after a possible, initial hike in the first quarter -- would be too much for Ukraine to endure. End summary. ¶3. (SBU) Comment and request for guidance: The deal appears to be a step in the right direction, but much more needs to be done. Tymoshenko will need to come clean on the pricing formula and other details, otherwise she will openly subject herself, and the agreement, to permanent second-guessing and attacks by her political opponents. Ukraine also needs to use this agreement to finally take strategic steps towards reducing dependency on Russian gas imports and strengthening energy security. Key actions include increasing transparency and reducing corruption, expanding and refilling storage, boosting transit capacity and modernizing the aging yet powerful gas pipeline network, charging full cost recovery prices domestically while giving targeted subsidies to the needy, increasing energy efficiency and expanding domestic production. The USG should be prepared to help, and we ask for guidance on when we should convene the first bilateral and trilateral energy security meetings as foreseen in the recently signed U.S./Ukraine Charter. End comment and request for guidance. Step in the Right Direction, But Questions Remain -------------- -------------- ¶4. (SBU) The gas agreement announced by Prime Ministers Putin and Tymoshenko on January 19 contains several of the key elements of what is universally seen as a badly needed long-term gas strategy for Ukraine. It foresees a swift movement towards market prices for both gas and transit, and it pledges to eliminate intermediaries in the bilateral gas trade. At the same time, many details are still unknown, and it remains unclear whether the new arrangement will actually bring to the bilateral gas relationship the accountability and transparency both Putin and Tymoshenko have claimed in their public statements since the deal was signed by Gazprom and Naftohaz. What is the "European" Price? -------------- ¶5. (SBU) The agreement foresees that Ukraine will pay "European prices" for gas, but will receive a 20 percent discount, while Russia will pay the same gas transit fee it paid last year ($1.7/tcm per 100km). The deal was struck for ten years, yet it was unclear how much of its substance would be determined in future years. On January 19, for example, KYIV 00000107 002 OF 003 Tymoshenko claimed Ukraine also would get a 10 percent discount in 2010 on European gas prices. In addition, the 2010 gas transit price has yet to be finalized, but in the press Gazprom Deputy Head Aleksandr Medvedev said on January 20 that Gazprom will pay Ukraine $2.5/tcm per 100 km for gas transit in 2010. ¶6. (SBU) Neither side explicitly stated what "European" price will be used as a basis for the calculations. On the afternoon of January 20, Tymoshenko said that according to GOU calculations Ukraine would pay $228.80 per tcm for 2009. She stressed Ukraine would pay this price throughout the year. This contradicts earlier GOU and Gazprom statements where it appeared the gas price would initially be set at a rate at least double the $179.5/tcm that Ukraine paid in 2008, but drop as the year progresses. Deputy Prime Minister Nemyrya told the Ambassador that Ukraine would pay about $360/tcm in the first quarter of 2009. Presidential energy advisor Bohdan Sokolovskiy also stated that Ukraine would be paying $360/tcm. This would imply an initial "European" price of $450 for Ukraine, equivalent to what Putin and Gazprom had said Ukraine would need to pay in the first days after Russia had cut off gas supplies. Nemyrya pointed out, however, that the price will be linked to a moving average of recent oil prices. Prices are expected to drop significantly during the course of 2009 as a result. Nemyrya told the Ambassador that the average price for the entire year would be in the range of $230 - $235 per tcm. Gazprom Deputy Chairman Aleksandr Medvedev stated that Ukraine's average gas import price in 2009 may be less than $250 per thousand cubic meters (tcm). To keep the ultimate average price low Ukraine may opt to consume gas in storage and only begin purchasing Russian gas at a later date, when prices are expected to drop, but it was unclear whether the agreement permits such a strategy. Neither side announced any volume figures for 2009 deliveries. In 2008, Ukraine agreed to purchase 55 bcm. ¶7. (SBU) Ukraine accepted a transit fee of $1.7/tcm per 100km, equal to the fee Russia paid in 2008. The sides agreed to set the 2010 fee based upon a "European" formula, but did not describe the formula in greater detail. Tymoshenko Announces Deal on Technical Gas -------------- ¶8. (SBU) On January 19 Tymoshenko also stated that Ukraine would purchase 11 bcm of technical gas -- needed to fuel compressors along the transit route -- for $167/tcm. Both the volume and price raised eyebrows in Kyiv. In 2008 Ukraine purchased 6.5 bcm of technical gas from Russia to pump 116 bcm of gas to other European countries. Transit volumes are expected to be less in 2009 because of the ongoing economic crisis, so the 11 bcm is far less than what Ukraine needs this year, unless the sides agreed to a time frame for the delivery and usage of the gas. In addition, in the past Russia made no distinction between prices for gas deliveries and for technical gas to Ukraine. ¶9. (SBU) If Tymoshenko's statements are accurate, then the technical gas side-deal may be part of an arrangement to keep the transit fee optically low. As the crisis unfolded, Ukraine insisted that it could only pay a higher gas price if the transit fee were increased as well. On the surface Ukraine compromised on this issue, because it has accepted a sizable increase in the gas price without any increase in the transit fee. ¶10. (SBU) PM Advisor Haidyuk (reftel) told the Ambassador that Gazprom feared that a transit fee hike would cause a chain reaction among other transit countries demanding similar increases. Ukraine offered to keep the transit fee unchanged in exchange for cheaper technical gas -- and cited a figure of $90/tcm, but Gazprom had refused. The surprisingly low price for the technical gas -- if indeed it is true what Tymoshenko has claimed -- could in fact reflect a compromise that the two sides struck in order to reach an agreement. Technical Gas Linked to RUE Ouster? -------------- ¶11. (SBU) The 11 bcm of technical gas may also be linked to the decision to remove RUE from the bilateral gas trade. It KYIV 00000107 003.2 OF 003 has been openly acknowledged that RUE owns 11 bcm in Ukraine's underground storage facilities. Haidyuk told the Ambassador that during the negotiations in late 2008 Russia said it would remove RUE if Ukraine would purchase this gas from RUE, since RUE had an outstanding debt to Gazprom roughly equivalent to the market value for the 11 bcm in Ukrainian storage. In addition to questions about price, it is unclear whether Ukraine will purchase 11 bcm in technical gas from RUE, or directly from Gazprom. If Naftohaz uses only 5 bcm, for example, to transport gas this year, 6 bcm would remain that could be sold to Europe for twice the amount Ukraine paid or stored to be used as technical gas at a later date. Gas Flows Resume on January 20 -------------- ¶12. (SBU) In any case the agreement places Ukraine in a comfortable position to resume transit flow. On January 20 Naftohaz confirmed that Russian gas was entering Ukraine; Separately, Gazprom stated that it was pumping gas thorugh all entry points in Ukraine. Naftohaz said it withdrew gas from its storage facilities in western Ukraine to resume deliveries to Slovakia. Gas deliveries to Romania and Bulgaria via the Orlivka metering station would take more time, but it promised to move all gas further westward within 36 hours of receiving it from Russia. RUE Out, But What About Gazprom Subsidiary? -------------- ¶13. (SBU) Both Putin and Tymoshenko acknowledged that RUE would be removed from the bilateral gas trade. The fate of Gazpromsbyt remained unclear. Gazpromsbyt, a 100 percent subsidiary of Gazprom, was a creation of the 2008 gas deal and replaced intermediary UkrHazEnerho. Gazpromsbyt gave Gazprom a footing in Ukraine's domestic market, and permitted Gazprom to sell 7.5 tcm of gas to Ukrainian industrial customers, who are the most attractive segment of the Ukrainian market since they pay full, unsubsidized market prices. Baloha Criticizes Deal -------------- ¶14. (SBU) President Yushchenko has been silent since Tymoshenko returned from Moscow, but on January 20 Viktor Baloha, Head of the Presidential Secretariat, openly criticized the deal. He said the failure to publish an exact pricing formula "gives grounds to suspect corruption," and claimed that certain EU countries pay less than $300 for Russian gas. He said experts would assess that the price negotiated by Tymoshenko would ultimately prove to be too high for the Ukrainian economy. He also warned against attempts to subsidize Naftohaz, as this could put the company "on the verge of artificial bankruptcy." TAYLOR